Signatures Didn't Underwrite This Rally

The predictions for an Aug. 14 rally were right, but for the wrong reasons.

Since the Securities and Exchange Commission said on July 2 it would require CEOs to attest to the accuracy of their filings, Aug. 14 came to be regarded as D-Day for the market. When corporate America sorted itself out for the public, experts believed, it would provide rocket fuel for the stock market as a whole.

And true to the theory, market indices began rising off their lows just after midday, when it became apparent the vast majority of companies would comply with the edict. The Dow Jones Industrial Average -- which had been down as much as 130 points, reversed itself and finished up 260 points at 8,743.3, while the Nasdaq closed up 65 points at 1,334.

"As more companies signed off, we got some relief," said Peter Blatchford, a trader at Miller Tabak.

But a closer reckoning strongly suggests Wednesday's gains probably were not the result of confidence-building alone, and likely the consequence of a somewhat obscure shift in asset allocation, along with a rethinking of Tuesday's selloff and old-fashioned short covering.

Many traders argued that the real impetus for the turnaround occurred when Treasury yields plummeted to 30-year lows levels just after midday. The 10-year note fell below 4%, while the yield on the 30-year dropped under 5% -- and that's when sentiment emerged that stocks were way oversold.

"That is when we saw the asset reallocation," said Holly Liss, an analyst at Mizuho Futures. Indeed, several traders said at least one participant and possibly several started moving sums of $1 billion or more out of bonds and into stocks, driving the market higher.

"The rally had more to do with an asset reallocation than it did with a change in fundamental market psychology," said Jim Volk, a trader at D.A. Davidson. "People sold bonds and bought stocks."

An overreaction to the Federal Reserve's announcement on Tuesday also may have been a factor. On Tuesday, the Federal Reserve kept interest rates at 1.75%, their lowest level in 40 years, and left the door open for additional easing, as expected. The knee-jerk response was a selloff.

"The kind of trading we saw on Wednesday is what we would have expected after the Fed decision," said Kevin Flanagan, a bond trader at Morgan Stanley. "The market got what it was looking for."

When the S&P 500 broke through 910 -- its most recent high -- traders observed short covering as well as some legitimate buying. The broader index closed up 35.4 points at 919.

Some experts are skeptical whether the Aug. 14 rally is the confidence-builder the market needs. "It is good CEOs are signing off," said Ray Hawkins, a trader at J.P. Morgan. "But if they are dishonest in the first place, what is to keep them from taking their chances and seeing if they get caught."

More important for the market is a restoration of the economic recovery -- consumer confidence, manufacturing, and employment data are still weak. For that, investors will have to wait for another day.